The mobile handset market is set for recovery after the worst economic downturn since the Great Depression, according to Nokia, the world's largest maker of cell phones.

The cell phone market has been hit particularly hard by the worldwide economic slowdown. And companies such as Nokia and Sony Ericsson have taken a beating.

The second quarter of 2009 was particularly hard for Nokia. The company's earnings were ugly with a 25 percent drop in revenue, a 15 percent drop in handset shipments, and a more than 70 percent decline in operating profits, compared to the same quarter in 2008.

Sony Ericsson, which reported its second quarter earnings just hours before Nokia, also had a poor showing in the second quarter. The company posted a 213 million euro ($301.4 million) net loss for the second quarter, which was down from a profit of 6 million euro ($8.5 million) during the same quarter a year ago.

But for Nokia and Sony Ericsson there are glimmers of hope in their results. Sequentially, Nokia's revenue and profits improved slightly compared to the first quarter of this year. And Sony Ericsson posted a narrower net loss than analysts had forecast.

These bits of positive news are likely contributing to a growing sense that the worst of the recession may be over.

This is good news for an industry that some market research firms have predicted will see at least a 20 percent drop in product shipments for 2009 compared to 2008. Nokia admits that neither its company nor the industry as a whole is out of the woods just yet. It reiterated on Thursday that it expects the industry to shrink about 10 percent in 2009 compared to last year.

These are all good signs that the economy is headed for recovery. But the climb back to robust growth could be a slow one. And there's no guarantee that a rising tide will lift all boats, especially in the mobile handset business.

Right now, the mobile handset market is going through a massive transition. Cell phones that were once used simply to make phone calls have evolved into jack-of-all-trade devices. Increasingly, cell phones are being used to provide Internet connectivity that allows people to use new forms of communication, such as social networking sites. Olli-Pekka acknowledged this trend during Nokia's second-quarter conference call with analysts and investors, noting that in the future more people will connect to the Internet via a cell phone than a computer.

"A new industry is emerging as the Internet and communications converge," he said. "And consumers will increasingly demand products that are more integrated."

Nokia has been at the forefront of developing devices that do just that. The company has led the market with its 3G wireless portfolio and it has led the market in terms of worldwide shipments with its smartphone devices, the N-series and E-series phones. On Thursday, it reported that some of these devices have been doing quite well worldwide. For example, it shipped 3.7 million 5800 series handsets during the quarter. And it also noted I has sold a total of 5 million units of its popular E71.

Smartphones are key
Smartphones in general are expected to lead growth in the industry as consumers look for more advanced features and easier access to the Internet and online applications.

But recently Nokia has lagged in terms of innovation here. Meanwhile, Apple is now viewed the leader in terms of innovation with its iconic iPhone. And other companies like as Research In Motion and Palm are also making advances with their own products. The new Google Android operating system, which will be on a whole slew of devices in the second half of 2009 and into 2010, is also expected to push the industry forward in terms of innovation.

Nokia and Sony Ericsson, each recognize that they need new products in the smartphone market to excite consumers. Sony Ericsson's flagship smartphone, Xperia, has so far not been particularly strong. But the company is working on other new products. And during a conference call with investors, Sony Ericsson Chief Executive Dick Komiyama said his company's new product portfolio should contribute to "healthier topline development" once shipments start later in 2009.

"The market is going through a huge seismic shift right now. People want more functionality in their phones, even the less expensive phones. They are demanding a good user interface. And they're refusing to put up with a bad Internet experience."

--Frank Meehan, CEO of INQ Mobile

Nokia's Olli-Pekka also noted that the company plans to increase its focus on developing more advanced phones.

"The line between handsets and PC will not exist in the future," he said. "And our ambition is to become the leading provider for these integrated mobile devices."

But Olli Pekka also emphasized the need to address the low and mid-range of the mobile market as well. And he emphasized the need for Internet connectivity and sophisticated technology in these devices as well.

"As we have said before, one size doesn't fit all," he said. "Nokia will continue to address all price points and all markets globally."

This is exactly the market that INQ Mobile, a new handset maker backed by Hutchison Whampoaa, is addressing. Smartphones may offer more growth, but basic Java-based feature phones still make up the bulk of the market. Today about 40 percent of the cell phone market is made up of phones that operators buy for between $36 and $99, according to Strategy Analytics. These are typically basic feature phones. Smartphones, which sell to carriers for more than $300 a pop, make up about 17.8 percent of the market currently, says Strategy Analytics.

In terms of market share, these figures are not expected to change much over the next few years. Mass market devices, which are in the mid-tier in terms of pricing, will continue to make up about 40 percent of the overall cell phone market well into 2014, the firm has said. But this doesn't mean that the average consumer will settle for me-too low-functioning devices. They are increasingly demanding more advanced functionality in lower-priced devices.

"The market is going through a huge seismic shift right now," said Frank Meehan, CEO of INQ Mobile. "People want more functionality in their phones, even the less expensive phones. They are demanding a good user interface. And they're refusing to put up with a bad Internet experience."

Meehan believes that this market has been largely overlooked by the major cell phone manufacturers, which have done a poor job integrating Internet-based applications and social networking into their devices. His company is trying to address this void with new, inexpensive devices that make it easier to access Internet based applications like Facebook with a single click.

The challenge for companies such as Nokia and Sony Ericsson over the next couple of years as the industry moves out of the recession and toward Internet-enabled devices is to address the high-end of the market as well as the low and mid-tier of the market. For these companies it will require a balance between controlling costs and adding innovative new features. As Nokia's Olli-Pekka pointed out during the conference call, the winners in this new era in the cell phone market aren't apparent yet. But he is confident that Nokia can rise to the occasion.

About the author

Marguerite Reardon has been a CNET News reporter since 2004, covering cell phone services, broadband, citywide Wi-Fi, the Net neutrality debate, as well as the ongoing consolidation of the phone companies. E-mail Maggie.
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